U.K. Takes Hard Look at Cost of Private Finance Initiative

An audit of privatized contract to widen M25 highway found its procurement slow and expensive.

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The United Kingdom's Private Finance Initiative, one of the most established models for public-private partnerships, is facing an overhaul as policy-makers rethink the traditional parameters of project finance, procurement and management. The shift follows years of PFI use under the Labour Party when it was in power. Since the formation of the Conservative/Liberal Democrat government in 2010, Exchequer Chancellor George Osborne, a conservative, has raised concerns about "misuse of PFI," calling for a reassessment.

Government debt and tighter credit are behind the overhaul. The independent National Audit Office noted last April that the cost of debt finance rose during the recent credit crisis by up to 33%. A Parliament treasury committee said that paying off £1 billion in PFI debt would cost taxpayers the same as £1.7 billion in government debt.

The U.K. is deeply invested in PFI schemes as it is. NAO forecasts PFI payments across all PFI contracts for the 2010-11 fiscal year at £7.9 billion and for 2011-12 at £8.6 billion. About 800 PFI contracts are operating, representing a combined capital value of about £64 billion, say press reports. Faced with limited budgets, some public agencies may have selected PFI procurement not entirely on merit but because there were no other options, says another oversight report.

Further complicating things is that U.K. accounting rules allow PFIs to be recognized as off-balance-sheet transactions.

Private firms who compete for PFI work hope to see reasonable solutions. Anthony Rabin, deputy CEO at Balfour Beatty, says that despite concerns, past audits touted PFI as being more effective at delivering projects on time and on budget. "In most cases, the taxpayers got what they bargained for and what they expected," he says.

But a 2010 audit of the £6.2-billion, 30-year design-build-finance-operate consortium contract to widen the M25 highway noted that procurement issues led to an 18-month delay. The project was finalized in 2009, after the credit crisis hit, which increased the net current cost by £660 million. In general, the procurement regime wasn't bad, but was slow and expensive, says Rabin. "Things could be done to make it faster and cheaper." Too few skilled managers is another problem. "We have hospital trusts that are self-governing and only do one deal to replace [a] hospital, therefore the skills … are limited," he says.

Stephen Cooper, a Skanska executive vice president in Europe, suggests more centralized procurement and management. "That could easily be done in schools, where projects could be bundled," he says.

The government could also boost value by expanding potential financiers on PFI projects from not only bank debt but other options such as pension funds, if they can accept the construction risk, Cooper says. Furthermore, he suggests allowing a mix of bank debt and government money, such as through the U.S. Transportation Infrastructure Finance and Innovation Act. Such a vehicle doesn't exist in the U.K.

Ignacio Barandiaran, principal and head of transaction advice at Arup, says the U.K. system struggles with contract flexibility during the operation phase, especially on hospital projects.

Despite obstacles, Rabin sees a path forward. In recent years, several PFI projects were canceled, while others moved ahead, not signaling a full retreat, particularly for transportation. "Our chancellor has recognized that, short term, we have a gloomy economic scenario," he says. "Whether people like it or not, private financing has to be part of the plan to tackle the problem."

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